Using RMD $ to Convert to Roth
Example:
Investor is required to take a 70 1/2 RMD of $100,000, however, only needs $75,000 to live on. It was decided to take the extra $25,000 from the IRA and convert to a Roth IRA. Woops – then realized this isn’t allowed.
Can we clear up the problem by taking another distribution of $25,000 and be okay with the other $25,000 we already converted?
Reason I’m asking is I read: “the RMD must be removed before the conversion can occur. The RMD cannot be converted and cannot be left in the Traditional IRA at the time of conversion. The first amounts removed from the Traditional IRA represent the RMD.”
or – do I need to reverse the conversion, do the full RMD and then do a new conversion?
Permalink Submitted by Alan Spross on Wed, 2010-05-12 17:17
You are correct that the first distribution in an RMD year is deemed to apply to the RMD. Therefore the RMD has now been satisfied. The problem is that the 25,000 conversion of part of the RMD is not allowed because an RMD is not eligible for rollover.
To correct this, advise the Roth custodian that the 25,000 is an excess contribution to the Roth and it needs to be distributed plus or minus any earnings attributed to the conversion. He will report 100,000 plus or minus any income on line 15 of Form 1040. After the corrective distribution he can convert any additional amounts that he wishes.
With an IRA this large, he may want to convert a larger amount this year. If his tax rates go up in 2011 he has the option to opt out of the two year deferral and report the conversion income in 2010.
Permalink Submitted by Kim Stark on Fri, 2010-06-04 20:05
As always, this is a forum is a great resource.
One more question. I’m going to give numbers to try and make it easier to follow…………..
Investor converted $30,000 to Roth. They should have taken this as an RMD instead. As luck would have it, the market is down since the conversion and they will only receive $28,000. From Alan’s response below, it appears he will be able to only take the $28,000 as a distribution on form 1040. That doesn’t work because to meet their RMD, they have to take an additional $2,000 – therefore, has a “realized” loss of $2,000.
If that’s the case, can/should they do a recharacterization vs. excess distribution?
Permalink Submitted by Alan Spross on Sat, 2010-06-05 00:17
No, they should clearly not do a recharacterization because the amount of the RMD they converted is not treated as a conversion per (c) in IRS Reg 1.408A-4, Q&A 6 copied below:
>>>>>>>>>>>>>>>>>>>>>>>
Q–6. Can an individual who has attained at least age 70 1/2 by the end of a calendar year convert an amount distributed from a traditional IRA during that year to a Roth IRA before receiving his or her required minimum distribution with respect to the traditional IRA for the year of the conversion?
A–6. (a) No. In order to be eligible for a conversion, an amount first must be eligible to be rolled over. Section 408(d)(3) prohibits the rollover of a required minimum distribution. If a minimum distribution is required for a year with respect to an IRA, the first dollars distributed during that year are treated as consisting of the required minimum distribution until an amount equal to the required minimum distribution for that year has been distributed.
(b) As provided in A–1(c) of this section, any amount converted is treated as a distribution from a traditional IRA and a rollover contribution to a Roth IRA and not as a trustee-to-trustee transfer for purposes of section 408 and section 408A. Thus, in a year for which a minimum distribution is required (including the calendar year in which the individual attains age 70 1/2, an individual may not convert the assets of an IRA (or any portion of those assets) to a Roth IRA to the extent that the required minimum distribution for the traditional IRA for the year has not been distributed.
(c) If a required minimum distribution is contributed to a Roth IRA, it is treated as having been distributed, subject to the normal rules under section 408(d)(1) and (2), and then contributed as a regular contribution to a Roth IRA. The amount of the required minimum distribution is not a conversion contribution.
>>>>>>>>>>>>>>>>>>>>>>
Accordingly, investor should report a taxable distribution of 30k on line 15 of Form 1040, but NOT a conversion on Form 8606 since this is not treated as a conversion despite the original intent. The excess regular contribution to the Roth IRA needs to be corrected, and due to the loss in the Roth the investor will only receive 28k. Note that if this investor has earned income, and since income limits no longer apply, some of the Roth intended conversion can be treated as a regular contribution for which he is actually eligible. For example, if he has earned income of at least 6k he would be eligible for a regular Roth contribution up to that amount and his excess contribution would be reduced to 24k rather than 30k. The amount he would get back for correcting a 24k excess contribution would be a little more than 22k.
Finally, note that virtually every IRA related advice correctly states that the RMD must be taken first. But you will rarely find the correct “fix” if that happens. The reason you won’t read about the correction procedure is that the IRS rarely detects the order in which the conversion and RMD were done because it is not reported to them by the custodian. Therefore, it would have to be discovered via audit. Since the correction procedure is not widely known, probably within and outside the IRS, you could expect that IRA custodians would be giving all kinds of incorrect advice. In this case, the investor might have to explain the procedure to the custodian because the 1099R needs to reflect the correction coding, and the tax return must reflect the 1099R. In this case, an explanatory statement should be submitted with the tax return in the hope the IRS will be able to understand what was done and why.